Friday, March 20, 2009

Despite all that has happened there are still some good businesses at AIG. 21st Century – an auto insurance company largely based in California is one.

AIG was not fraudulent from top to bottom – and not everyone working there stuffed up the real economy though AIG FP was probably ground zero for bad lending.

I have no idea what the guy who runs 21st century is paid – and I haven’t looked. But if 21st Century were private – and I controlled it – I would have no problem paying a good guy there 15-20 times average earnings – that is something in the 1-1.5 million range. Those sums would make the said executive extraordinarily wealthy by the standards of the average American. If he is good – and I was a shareholder – I would just wear it.

I might make a fair bit of the salary bonus – and make it contingent on some performance metric – but I would have no problem justifying it.

I would have an awful time justifying paying the guy 50-100 times average. There is just nothing that the guy could do that would justify that incremental level of salary.

We have executives paid 30 million a year and executives paid 1.5 million a year and they generate the same level of outrage on Main Street where (compared to say $65000 in household income) both numbers are incomprehensible. That said – 30 million per annum is enough money that you can’t spend it unless you run multiple houses with servants and fly private jets fractional share. 1.5 million per annum buys you an upper middle class life in Manhattan – or an opulent existence in Los Angeles – but multiple houses with servants are still out of the question. Private jets are unthinkable.

The bonuses paid at Merrill Lynch were 3.6 billion - 22 times the AIG bonuses.

They were paid by a firm that would not have survived without a bailout by the US Government through Bank of America. Moreover they were sometimes large – the 30 million variety – not the 1.5 million variety.

We should be at least 20 times as outraged over the Merrill Lynch bonuses than the AIG bonuses. But as a society we are not.

And don’t tell me it is because AIG is ultimately public and Merrill Lynch private. I used to be a retail fund manager – and my end investors included a broad cross-section of society. The low paid council worker was a part owner of companies where senior staff were paid $20 million per annum.

I have come to the conclusion a long time ago that most people are ill equipped to handle large numbers. They can’t see the difference between a billion and a trillion. This leads to irrationality in bull markets and bear markets. The irrationality is common amongst rich and poor and across genders and political views.

There has to be investment opportunities in that. But also in the eyes-glaze-over aspect of big numbers there are plenty of opportunity for management to loot shareholders entirely.

Because most people can't tell the difference between a 1.5 million bonus and they are innured to 35 million ones if you really are a 1.5 million per annum exec (say the CEO of 21st century) you ask for 30 and settle for 5.

Anger arb is a game here. People do not think clearly about large numbers.

I know this isn't the tone du jour on finance blogs, but I think your point about large numbers is as much a cause of the crisis as anything. Bankers, executives, and fund managers are truly delusional about the money they had been making. They didn't see it as being exceptional and mostly didn't plan for its end.

I live in a neighborhood of gilded age mansions and see how in another age men assumed their level of success was permanent. But it wasn't, the very large number should have indicated an exceptional windfall. But somehow, they never grasped that and the mansions had to be liquidated and turned into apartments. Something similar will happen presently.

I agree with the glazing over effect when it comes to large sums of money. Many in politics can not process the ideas of millions, billions and trillions. Thus any numbers that end with "ions" attached to compensation is deemed outrageous.

The AIG debacle is nothing but political grandstanding. It's dishonesty on the part of politicians and media that had everything to do with the crisis in the first place. Although by diverting attention and scrutiny away from themselves, and hanging effigies of executives for the public to burn, they have so far escaped the wrath of populist anger.

People have been making ungodly sums of money in the financial markets since they have existed. they are getting taken to the woodshed now, but believe me, they will be back.

That is a nice story about wht you would pay your 21 Century manager, but you leave yourself open to the probability that your CEo office would be a revolving door to places that would pay more. Its just the ay it is.

Should have included this earlier, but what do you pay someone who brings in $1B high margin revenue? Those are the kind of numbers these people get paid on. If they don't get paid big, they will either go home, start their own shop, or go to a competitor who will. You might as well grouse about sports or movie star pay.

I am rather amused by the bonus legislation. The legislators are not aware of the consequences.Let's consider a somewhat typical husband and wife in NYC I happen to know very well.The husband makes 115k base, 100k bonus.The wife makes 125k base, 25k bonus.They work hard, have a good life, but they also donate time and money to charities, and they are friendly, open-minded and respectful of cultural and religious differences. Few comparisons with Gordon Gekko hold up.Total income: 375k. If one of them or both were to resign sometime in the middle of 2009, the combined pre tax income would drop to 200k or so, certainly below 250k. Their net income would be roughly the same.Even better, the husband or wife would get themself fired, so they could collect some unemployment from the government. If this legislation passes the senate, expect unemployment to increase dramatically.

The husband would feel some regret about his recent marriage though. Without the marriage, this legislation would have not impacted the couple at all.

Directors of public companies appoint each other to boards and set each other's pay. Provided their pay isn't so large that it shows up as a major cost item to the company, they can set each other's pay however they want. It's not in the shareholder's interest to create a major fuss pushing their share's price down unless the pay is a big chunk of revenue. It's not a job market at all, it's just groups of "in" people creaming off what they can for themselves.

If "juries" from among the shareholders appointed directors and set pay, you'd actually see a job market and get very different results.

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The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.